Like A Bad Neighbor
This spring, Texas’ biggest insurance company took the unusual step of trying to hike homeowner’s insurance rates for the second time in eight months. The first increase had come in September 2009, when State Farm Lloyds Inc.—a division of the giant insurer that handles the most residential policies in Texas—jacked its monthly premiums by 8.8 percent. Then in April the company, which controls nearly 30 percent of the market, informed the Texas Department of Insurance (TDI) it planned to raise rates again, this time by 4.5 percent.
For the average State Farm customer in Texas, the two rate hikes would equal about $198 more in premiums each year. But that wasn’t the biggest worry for Mike Geeslin, commissioner of the Texas Department of Insurance. Rather, what worried Geeslin the most was the possible follow-the-leader effect. Because State Farm is the largest player in the market, its pricing has an outsized influence on other insurers. Rate increases are typically smaller and spaced out over longer periods. If State Farm raised rates again, Geeslin feared, other insurers would assume that State Farm knew something they didn’t—and raise their own rates.
Geeslin’s power to say no is limited. In fact, Texas’ chief insurance regulator has little direct control over insurance rates. So he wrote State Farm a letter, asking the company to wait. So many rate hikes in such a short time “may indicate a lack of rate making discipline and lead to market instability,” he told State Farm.
After nearly a decade of politicians promising reform, Texas already had among the highest rates in the country. Until Florida passed us this year, Texas’s rates were the nation’s highest for homeowner coverage—higher than states with more expensive homes and greater threats from natural catastrophes. Was Texas headed back to last place?
“It is my hope,” Geeslin’s letter concluded, “that State Farm Lloyds reconsider the timing of this filing and will voluntarily withdraw it.”
That was a quaint notion. State Farm responded that it had taken TDI’s objections under advisement, but would move ahead with the rate hike anyway.
At that point, Geeslin tried another strategy—public embarrassment. In its rate-increase filings, according to State Farm spokesperson Kevin Davis, the company included information justifying its request. Geeslin thought one justification—rising costs of “reinsurance”—would look particularly bad if Texans knew about it.
Reinsurance is insurance that companies like State Farm buy to protect themselves against a catastrophic number of claims. It’s essentially insurance for insurance companies. On paper, it’s a way to diversify the risk of some horrific regional disaster—a Category 4 or 5 hurricane, for example. But increasingly, companies are making their customers pay for it. Reinsurance costs, says state regulator Deeia Beck, “are becoming a bigger and bigger part of homeowner premiums.”
Beck heads the Office of Public Insurance Counsel (OPIC), a state agency that advocates on behalf of Texas insurance customers. She says reinsurance makes up about 10 percent of the average Texas homeowner premium. So if you’re paying $1,200 a year—about average—$120 is going to reinsurance.
Where does that money go? Some of it comes straight back to State Farm. Reinsurance is one of the least-transparent, least-regulated areas of insurance. Most providers are beyond the reach of regulators in money havens like Bermuda, the Cayman Islands and Switzerland. One of the biggest reinsurers is State Farm Mutual Automobile Insurance Co., the parent of State Farm Lloyds. In effect, State Farm is jacking up its profits by “buying” insurance from itself—and charging customers for it.
“It’s a giant shell game,” says Alex Winslow, head of the nonprofit watchdog group Texas Watch. “State Farm Lloyds buys reinsurance from the national State Farm—and they mark that as a loss on their books.” They then “use that as an excuse to hike their rates.”
State Farm Lloyds says there’s nothing wrong with buying reinsurance from State Farm; the company just doesn’t want anyone to know about it.
Geeslin thought the public should know. Armed with data the company had provided, he wrote State Farm again and said he was considering placing the reinsurance data on the Insurance Department’s website. State Farm balked and threatened a lawsuit. In a statement on its website, the company argues that “these documents contain confidential proprietary information that is valuable to other insurers and would harm our competitive position.”
Geeslin could have posted the information anyway. Instead, he asked a state district judge for permission. The judge upheld State Farm’s claim that the information needed to remain secret. Now the rate filings are locked away at TDI. No one but the commissioner and his actuarial staff can look—and State Farm customers can’t tell how much they’re paying the company to insure itself.
The episode says a lot about the weakness of insurance regulation in Texas.
And it reflects a broader trend in Texas: State government fails to rein in the excesses of large corporations while consumers pay the price. The recent history of State Farm vs. Texas is a perfect example.
State Farm has been quarreling with Texas regulators for five years. And the company has mostly come out victorious.
The legal battle between State Farm and the TDI began in 2003. That year, the state Legislature passed a huge insurance reform bill that was highly favorable to industry. The bill implemented the system that allows companies to hike rates without permission from state regulators. It also ordered a comprehensive review of homeowners insurance rates. During the investigations, TDI determined that State Farm’s rates were “excessive,” and the department ordered a 12 percent rate reduction.
State Farm refused and took TDI to court. This would become a pattern. After five years of legal wrangling, a district court ordered hearings on whether State Farm had overcharged. But, while the dispute plays out in court, Beck calculates that State Farm has continued to charge “excessive rates,” adding up to $1 billion in overcharges from 2003 to 2008.
Beck took her findings to TDI Commissioner Geeslin, who had been appointed by Gov. Rick Perry to lead the department. The Insurance Department’s actuaries determined that State Farm had indeed overcharged, though by less than Beck had calculated. In 2009, Geeslin ordered State Farm to return more than $310 million.
Once again, State Farm balked. The company took the TDI back to court on a technicality—and there it remains. Last November, a state district court found that Texas regulators could order State Farm to refund the money. State Farm appealed. The rate dispute is still in court. The company has yet to pay a dime.
This was hardly an anomaly. “State Farm has been the most aggressive of all insurers in the state when it comes to bucking TDI,” says Texas Watch’s Winslow. “It constantly uses its size to bully the department. Time and again, it refuses to comply with the TDI orders, instead choosing to litigate.”
It matters little whether State Farm wins these battles, Winslow says. The point is to keep regulators so busy that they think twice before challenging State Farm.
The sequence of claim and counterclaim, suit and countersuit, is almost like a vaudeville routine. Every player has its own numbers, its own agenda, its own definitions of terms. Insurance is supposed to be straightforward, a matter of pure math. Instead, it’s a wonderland of exotic creatures and magic words, a world where everything normal is turned upside down. Insurance disputes often are underplayed in the public and press because they’re so complicated.
Take insurance regulation. It’s based on the idea that there is such a thing as an excessive rate. Whether a rate is determined to be excessive is the result of a complex and baroque set of actuarial calculations, but the basic rule of thumb is that 60 percent of the premiums collected by insurers are supposed to be paid out in claims. The remaining 40 percent can go to profit and business expenses. If State Farm or another insurer is paying out less than 60 percent in claims, regulators can order the company to reduce its rates. If they find that rates have been too high, TDI can order the insurance company to refund the overcharges to customers.
Regulators base those requests on long-term trends. “One year does not an average make,” Beck says. It’s the long-term averages that matter, and rates shouldn’t vary that much from year to year. The fact that a company loses money one year doesn’t mean its rates were fair, just as the fact that it made money one year doesn’t mean they weren’t.
In practice, rate reductions and refunds are rare. One reason is that state regulators are chronically overwhelmed by rate requests. According to Ben Gonzalez, an Insurance Department spokesperson, state actuaries were still reviewing State Farm’s September 2009 rate increase when the April 2010 request came in. This might sound like an easy problem to fix: Hire more actuaries. Even if legislators were willing to raise the Insurance Department budget, there would still be a problem: The numbers in rate filings would remain slippery.
“We all have actuaries,” says department spokesperson Jerry Hagins. “When we try to figure out how much companies should be charging, OPIC’s numbers are the lowest, State Farm’s are the highest, and ours are somewhere in between.”
Each defines “loss” differently. Consumer advocates think insurers should base rates on how much they’re paying in claims—the “pure-loss ratio.” It’s designed to force insurers to be efficient with their expenses.
Insurance companies don’t like that metric. They want to set rates according to a “combined-loss ratio,” which counts losses plus expenses. Using that formula, State Farm claims it has lost money over the last 15 years on homeowner insurance in Texas.
Addressing the Insurance Department’s claim that the company owes $310 million to customers, State Farm argues on its website that it can’t have been overcharging customers because it’s losing money. “As our public financial statements show, State Farm Texas’s homeowners insurance business overall, for the past 15 years, has been unprofitable, despite State Farm’s use of the rates TDI now seeks to reduce retroactively.”
Beck says this is simply not true; that $1 billion (or $310 million) in overcharges was “money that State Farm collected that they shouldn’t have. They were definitely making a profit.” Would the company stick around otherwise, she asks, “out of the goodness of their hearts?”
What State Farm means by “unprofitable” is that expenses were greater than revenues. What constitutes expenses? According to Davis, the company spokesperson, “overhead, building costs, and employee compensation.” Also “reinsurance expenses,” which include the money that State Farm Lloyds pays to the parent company for reinsurance. That’s what Texas Watch calls “moving money from one pocket to another.”
“There’s very little transparency,” Beck says. “We don’t know: Has the insurance carrier gotten a good deal? Does this diversify the risk? Is the reinsurer a quality reinsurer?”
Not every insurance company needs reinsurance. “Remember what the point of insurance is,” Beck says. “It’s to spread around your risk. If you’re a little company in Houston and you write 90 percent of your policies on the coast, then yes, you should buy reinsurance, because if a hurricane comes along, you can’t possibly absorb that kind of loss.”
It’s less clear that a company like State Farm needs reinsuring. “They’re a large, diversified national company with risks spread,” Beck says. “They’re writing all over. They should be able to absorb a regional loss.”
Even if State Farm Lloyds needs reinsurance, Beck says, “it’s not clear how buying from their parent company helps to spread their risk.”
Beck would like to see the books. “We need not to have to just take the industry’s word that they are making good deals,” she says. “We need to be able to look at those deals and see that they’re legitimate and not ‘brother-in-law’ deals.”
But she can’t look. Nor can the public. State Farm sees no problem. “All of the information was submitted to the TDI,” says spokesperson Davis, “and the TDI acts on behalf of consumers on these matters, and they have these documents, and they make determinations on behalf of customers. Their role is to protect the public interest.”
But if we can’t see the information, how can there be any public accountability? How do we know the Insurance Department is doing its job? “I can’t comment on whether the TDI is doing its job,” says Davis.
On State Farm’s website, there’s a section called “Setting the Record Straight” that encapsulates the company’s attitude toward regulation. The company argues that it shouldn’t have to pay what TDI says it owes Texas customers—because it would have devastating effects on the business.
“The financial impact of this order on State Farm Lloyds,” the post reads, “is comparable to the financial strain caused by Hurricane Ike, the third most destructive hurricane to ever make landfall in the U.S. This decision not only challenges State Farm financially, it creates an unstable environment for consumers and the insurance industry.”
State Farm Lloyds repeatedly reminds website visitors that it insures 30 percent of Texas’ home owners. The implication is clear: If Texas regulators had their way, these people would be out in the cold.
“State Farm is constantly threatening that if the department keeps making it too expensive for them to stay here, then they’ll just take their marbles and go home,” says Winslow. “But that money they’re talking about? It’s all overcharges. It’s money they never should have collected in the first place. Cry me a river.”
“This has to stop,” says Beck, the state consumer advocate. “State Farm can’t just thumb its nose at the state regulators. You have to stay on these people, make them toe the line, make them behave, or all you’re asking for is more trouble.”
There’s more trouble—and higher rates—ahead if Texas doesn’t put some teeth into its regulatory system. Since Gov. Perry’s “reforms” went into full effect in 2004, Texas’ insurance regulation has operated under a system called “file-and-use.” Insurance companies can raise rates by notifying the insurance commissioner. Regulators call it “drive-by filing.” In some states, insurers have to get permission from state regulators to impose higher rates. In Texas, the regulators’ only option is to contest the rate hikes retroactively by taking the company to court.
Reformers say Texas needs a “prior-approval” system. It’s not a new idea. In 2002, when runaway home-insurance rates dominated the governor’s campaign between Perry and Democrat Tony Sanchez, both candidates pledged to use it. Instead, the state Legislature—with Perry’s backing—opted for the industry-friendly file-and-use system. Perry promised rates would drop. Instead, average rates have risen 9 percent since 2003.
Insurers blame the increases on over-regulation. They insist that prior approval would make things worse. The solution is always more “competition”—code for less regulation and oversight. “It is well documented,” State Farm spokesperson Davis says, “that, in business, competition results in better pricing for consumers.”
That was the rationale for “drive-by filing” in 2003. “Texas has one of the weakest
egulatory structures in the country,” Winslow says. “Where are those lower rates?”
The solution, Winslow says, is giving the Insurance Department “the tools it needs to do its job.”
Even with a prior-approval system, big insurers like State Farm could continue to sue state regulators and threaten to leave the state. That’s why reformers like Democratic state Rep. Jim Dunnam of Waco, the Democrats’ House minority leader, support a more dramatic measure: electing the insurance commissioner now appointed by the governor. “Right now,” Dunnam says, “the governor can hide behind the insurance commissioner—even though he controls the insurance commissioner. If the governor wanted to crack down on this, he could.” If the commissioner were elected, at least she or he would have to answer to voters—including those angry about rising rates.
But an elected commissioner would only help so much. Regulators can’t regulate without better tools. And even with better tools, there’s no guarantee they’ll truly protect consumer interests.
“Whatever regulatory system you put in place,” says Beck, “the regulator has to take their job of regulation seriously.”
There’s no way to know whether Texas’ insurance regulators are doing their jobs—even within the constraints imposed by state law. It’s not just reinsurance contracts that are hidden from public scrutiny; the industry and its regulatory system are shrouded in darkness. There’s no way for Texans to know whether State Farm is being honest about its profits and losses, or whether the Insurance Department is working to keep companies honest.
So the final step on Texas’ long and uncertain road toward insurance regulation would be to shine more light. “There has to be government accountability,” Winslow says. “The public has a right to know what their government is doing, and they should be able to hold TDI accountable for the decisions they make.”
Next January, when a new Legislature arrives in Austin, reform-minded legislators and activists will try again.
Saul Elbein, a former Observer intern, is an Austin-based freelance reporter.